NZ Herald 18 April 2020

ASorry, but you’re not eligible to buy the shares. Only current shareholders can take part in the share purchase plan.

But that’s probably a good thing. I applaud your desire to help New Zealand companies cope with the Covid-19 — and few companies will be harder hit than Auckland Airport. But you’re right, I always recommend starting in shares by investing in a share fund.

Why? There’s a saying in financial circles that there’s no such thing as a free lunch. If you want to reduce your risk, you have to accept a lower average return. But there’s one exception, which applies if you invest in a wide range of shares, either directly or in a share fund.

You reduce your risk because not all the shares will fall, or go out of business, together. But you get the same average return as you would if you bought just one share.

Some interesting research quoted by financial adviser firm Bloomsbury Associates looked at the NZX50 share index and the 50 shares that make up the index, in the ten years ending April 2019. They found:

• Only 26 per cent of the companies had higher returns than the index, while 74 per cent — nearly three quarters — had lower returns. What’s more, 14 per cent made losses over that decade.
• Only one out of the 50 companies had lower volatility than the index. One!

That tells us there’s only a one in four chance of buying an individual share that performs better than the index. And it will almost certainly be more volatile than the index. As we’re learning lately, volatility can be hard to cope with.

I’m not saying that eligible people shouldn’t buy the Auckland Airport shares, especially as they are being offered at a discount. They might end up being a great investment for people who already hold a wide range of shares.

But for you starting out in shares, I think drip feeding into a low-fee non-KiwiSaver index fund over a few months would work best. There’s more on index funds, which simply invest in all the shares in a market index, below.

AThat is indeed a worry. The people who do well tend to crow about it. The others slink away.

Time and again it’s proven that most people don’t do well out of short-term share speculation. Unless you enjoy a gamble with a tiny portion of your savings, give it a miss.

AIt’s a sign of the times that you’re content with a 10 per cent drop in your KiwiSaver balance. But positivity is great.

Without knocking what you say, a few other funds have actually performed better, including at least one index fund.

This is of note because managers of actively managed funds, such as yours, like to point out that they can make moves to reduce losses before a market falls, whereas managers of index are stuck, unable to take defensive action. That means, the argument goes, that index funds perform worse in downturns.

But it seems most active managers aren’t actually that good at picking what to do when. Or perhaps they’re just too big.

“It’s worth noting that the increasing challenge for active managers in New Zealand is that they are now running quite large funds, and this makes it harder and harder to implement their strategies and to also react,” says Dean Anderson, founder and CEO of Kernel, an investment platform and index fund manager. “If you’ve got a billion dollar fund and the market starts to fall, you can’t just turn 40 per cent of it into cash easily.”

So how has Anderson’s Kernel NZ 20 Index fund performed lately? For the three months ending March 30 that fund’s return was minus 10.36 per cent after fees and before tax, according to Morningstar NZ.

That compares with your fund’s minus 13.11 per cent over the same period — despite the fact that your fund includes some non-share investments that were probably less affected by the downturn. (Your 10.5 per cent number is different, perhaps, because you’re including gains since March 30.)

Anderson adds that only 1 out of 15 active NZ shares funds beat his index fund in the period. The average active fund manager’s return was minus 13.6 per cent after fees and before tax. What’s more, Kernel’s commercial property index fund beat all its active fund competitors.

This isn’t a one-off. After the other significant NZ share downturn in the last few years, in October 2018, index fund manager Smartshares said, “Only two of the 19 NZ active equity funds beat the market, according to Morningstar, but all of our funds did.”

Similar stories come in from overseas. Right on deadline for this column I received a press release that starts,”This year’s market sell-off has triggered the worst underperformance for active fund managers against passive funds in years, according to the latest survey of 1,350 funds with assets totalling $4 trillion by Copley Fund Research.”

The upshot of all this? I’ve always recommended index funds — a.k.a. passive funds — because they are cheaper to run so their fees are lower. And over time their average returns after fees tend to be amongst the best. A few active managers might beat them, but nobody can pick which ones in advance.

I think we can conclude that index funds are the best bet in falling markets as well as the more common growing markets.

AYou got it slightly wrong about the 100 per cent cash. Fisher Funds’ Preservation Fund holds only 30 per cent cash and cash equivalents — securities that will mature in less than 90 days, says chief investment officer Frank Jasper. The rest is New Zealand fixed interest investments.

“All of the investments are securities rated A minus or better with a portfolio average rating of AA minus,” says Jasper. Many of them are issued by banks.

Most of the time these investments won’t lose value — or not so you would notice. However, “The Preservation Fund dropped in value by 0.28 per cent in March,” says Jasper. “While it is very unusual for cash and short maturity fixed interest investments to fall in value it can happen in extreme circumstances.

“We are living through extreme times and extreme levels of market volatility. The uncertain outlook in March meant investors demanded higher than normal returns to take on even modest risks.

“In a cash and fixed interest portfolio that resulted in wider credit spreads, the extra return demanded for lending to anyone other than the government, leading to higher overall interest rates.”

Got all that? The main point is that when interest rates rise, the value of fixed interest investments falls — and with it the unit prices in your fund.

So why not, as you suggest, just use a bank term deposit?

“Over time a portfolio made up of cash and short maturity fixed income investments, like the Preservation fund, is likely to deliver a return in line with bank term deposits — although returns will fluctuate month to month, quarter to quarter,” says Jasper.

But there are advantages over a bank term deposit:

• Diversification. Your fund invests in “a range of different entities including the NZ Government, banks and supranationals. While we would hope that the benefits of this diversification are never needed it’s a good thing to have,” says Jasper.
• Tax. The fund is a Portfolio Investment Entity (PIE), with a maximum tax rate of 28 per cent.
• Flexibility. Over 65s can withdraw money usually within a day or two, whereas term deposits are locked in.

Perhaps “Preservation” is the wrong name for the fund, but it seems to be pretty low-risk.

A Fisher Funds spokesperson adds, “Please pass on our apologies that the answer our team gave wasn’t adequate. I have followed up with our client-facing teams on this.”

AOuch!

Now that I’ve recovered, I’ve got a couple of questions for you:

• Why on earth do you read my column if I always get this wrong?
• Why is it that many of the angriest correspondents over the years have been big fans of gold? You should love that I’m not urging readers to buy gold. It reduces your competition.

Never mind. In these trying times we all get a bit testy occasionally. And I take your point — perhaps the gold chart should have been in New Zealand dollars.

But, as I was trying to point out, during the period the correspondent was looking at there had been a big drop in the Kiwi dollar versus the US dollar. So a lot of his gold gains were in fact currency gains. The chart removed that effect, and looked at just what happened to gold itself.

What’s more, everyone always quotes gold prices in US dollars. If you look at the Markets page in this section of the paper, you’ll see gold listed in American not Kiwi dollars. And on the radio they give the gold price in US dollars, often without even labelling it as such.

But okay, let’s look at the NZ dollar story — although not over 12 months. You can’t conclude anything over such a short period. How about the last 20 years? According to goldprice.org, over that period, up to last Wednesday:

• The price in US dollars has risen 524 per cent.
• The price in NZ dollars has risen 401 per cent. Hmmm.

This week’s graph gets around the currency issue by showing what would have happened to a $100 investment made in April 2000 in gold priced in both US and Kiwi dollars, as well as in the NZX50 share index including dividends. All numbers are before fees and tax.

Not only do shares win, despite the recent plunge, but you can also see how volatile gold is, zooming up after the global financial crisis, but then plummeting.

If you think about it, over time we would expect average shares prices to grow more than inflation. They represent ownership in companies coming up with increasingly better ways to produce goods and services.

I’m not so sure about gold. Sure it’s useful — in jewellery, dentistry, electronics and computers, medals and statues. But there’s always the threat that someone will come up with great substitutes for any of these.

AThanks for being fair and looking at another longer period — and for reporting back on it. It’s interesting to see your findings are similar to those in the above Q&A, for a slightly different period.

Clearly you’re not one of the people sometimes called “gold bugs” who can’t see past the shine!

A Perth Mint spokeswoman says one of its investment options is to buy unallocated gold, which doesn’t have any ongoing storage fee. But “there are several and differing fees pertaining to each of the account types we offer. These include transaction, fabrication and storage fees.” See their website.

AYou make some good points. I did say last week that holding some gold helps with diversification, but you go into this in much more depth.

But first, the buy/sell spread. That’s basically the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. A wide spread means the market isn’t “liquid”, so it might not be easy to sell gold at an acceptable price in a hurry.

Moving on to the importance of investing in a range of different assets, your comments echo mine in today’s first Q&A. Diversification across shares or across different types of assets can reduce risk without sacrificing return.

Academics at Trinity College, Dublin, in 2006 looked at the correlation between gold and share returns in the US, UK and Germany, to see if gold is:

• A good hedge, which means over time its price tends to rise when shares fall, and the reverse.
• A good safe haven in times of extreme market turbulence.

They found that gold is, indeed, a good hedge. “In addition, since the price of gold in the US increases when stock prices fall, gold has the potential to compensate investors for losses with stocks, thereby positively influencing market sentiment and the resiliency of the financial system,” say the researchers.

However, it’s not so good as a safe haven, if an investor doesn’t already hold gold over the long term but jumps in after shares plunge.

“Investors who start purchasing gold the day after an extreme negative shock lose money after about 15 trading days,” say the researchers, Dirk Baur and Brian Lucey. That’s because share prices tend to bounce back up, and so gold tends to fall.

The conclusion: consider holding a small portion of gold over the long term, to calm down movements in your whole “portfolio” of investments. But don’t jump in and out of it.